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Where's the Entrepreneur?


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06/26/2003Brad Dupont

Entrepreneurs are widely considered to be important parts of economic activity. Why would they not be studied carefully by the folks who are supposed to know so much about this activity?  

The mathematization of economic theory has been resoundingly ineffective in understanding of the role of entrepreneurs in economic activity. While Austrian economists and, increasingly, specialists in development and economic history have emphasized entrepreneurial activity, the world of the neoclassical economist is generally silent on what should be a prominent feature of any economic model. Just to illustrate the deafening silence of most standard treatments in economics, we can turn to some of the most widely used graduate-level texts in economics.

The massive 981 page PhD level text Microeconomic Theory by Mas-Colell, Whinston, and Green is a superb and voluminous treatise in the field but a quick perusal of the index to the book reveals an interesting fact—of the nearly one thousand pages contained in the book, only one page is devoted to entrepreneurs and that single page is a part of some end-of-chapter review questions, not the main text itself.

A much shorter but also excellent text in microeconomic theory is by Hal Varian. Varian's Microeconomic Analysis is much more compact (it is a mere 506 pages plus some reference and index material) but devotes no pages to the examination of the role of the entrepreneur.

David Kreps also has a widely used text in PhD level microeconomics called A Course in Microeconomic Theory. Alas, a quick examination of the index reveals that it too makes no mention of entrepreneurs or their role in organizing factors of production in its 850 pages of text.

It is then understandably exciting to turn to the index of Henderson and Quandt's Microeconomic Theory: A Mathematical Approach to find that page 64 does mention the entrepreneur. I excitedly turn to page 64 to find that the entrepreneur seems to be a pretty important fellow:

[A firm's] entrepreneur (owner and manager) decides how much of and how one or more commodities will be produced, and gains the profit or bears the loss which results from his decision. An entrepreneur transforms inputs into outputs, subject to the technical rules specified by his production function. The difference between his revenue from the sale of outputs and the cost of his inputs is his profit, if positive, or his loss, if negative. The entrepreneur's production function gives mathematical expression to the relationship between the quantities of inputs he employs and the quantities of outputs he produces. . . . An entrepreneur normally will use many different inputs for the production of output. . . . [The firm's] costs are incurred by the entrepreneur regardless of his short-run maximizing decisions. . . . The entrepreneur purchases inputs with which he produces commodities.1

Unfortunately, shortly after this lovely introduction, the authors turn to a mathematical derivation and description of the "theory of the firm" couched in terms of the production function where the entrepreneur falls from view. The problem with the production function approach is that when all inputs are specified and known to all firms in the industry (and there is a constant relationship between inputs and outputs), the entrepreneur becomes irrelevant.

Mentions of the entrepreneur are in fact scattered throughout the chapter on the firm but only in the context that the entrepreneur is a shadowy character who operates somewhere in the background doing something to somehow pull together different combinations of x and y.

Unfortunately, we end up with little understanding of the way in which the entrepreneur truly functions, how his economic environment influences his actions, and how various sorts of risk and uncertainty come into play in his decision making. To their credit, however, Henderson and Quandt do at least acknowledge the existence of an entrepreneur who is organizing factors of production.

This is much more than can be said of most texts (it is also an older text with copyrights in 1958, 1971, and 1980—reflecting the trend that the appearance of the entrepreneur in theoretical texts seems to diminish with time).

It is unfortunate that the entrepreneur does not play much of a role in microeconomics but what about macroeconomics?  Barro and Sala-I-Martin have an excellent graduate-level text called Economic Growth but, despite the importance of entrepreneurs in growth (especially in developing economies), there is no mention of them in this text.

Perhaps in something a bit more broadly focused?  Romer's Advanced Macroeconomics does use the concept of the entrepreneur in his section on Financial Market Imperfections but only in very general terms in modeling issues of asymmetric information in investment markets. There is no discussion on the role of the entrepreneur in the broader macroeconomy, development, or growth. Sargent's classic Dynamic Macroeconomic Theory is also silent on the issue.

So, perhaps I am wrong?  Perhaps the entrepreneur is not all that important. After all, Mas-Colell, Whinston, Green, Varian, Kreps, Henderson, Quandt, Romer, Barro, Sala-I-Martin, and Sargent—these are all quite prominent figures in their respective fields. While this is true, they are also largely locked into mathematical economic theory and developing a rigorous understanding of the entrepreneur and his or her actions as an agent in the evolving process of human behavior is outside the scope of that theory. So, what does it really matter?  This is just theory anyway, right?  

Not quite. Economists have an important role to play in the real world as policy advisers and no better example can be given than that of the transition economies. The IMF, World Bank, and other international economic organizations have been deeply involved in the transition process. What they are discovering, however, is that the tools of mathematical theory are ineffective in dealing with transition policy.

In a recent paper in the Journal of Economic Perspectives, McMillan and Woodruff2 write that not only are entrepreneurs worthy of study but they are central to the transition process. Writing of China early in its reform process,

These startup firms drove China's reform momentum; they were arguably the single main source of China's growth…They strengthened the budding market economy by creating jobs, supplying consumer goods, mobilizing savings and ending the state firms' monopoly (p. 153).

As the authors rightly point out, the IMF and other advisers were intently focused on privatizing existing enterprises but nearly completely ignored the other route to the private sector—the creation of new firms. This is what entrepreneurs do, and did, in the transition process in Europe, China, and elsewhere, yet it is nearly always neglected by economists because the theory upon which they rely is silent on the subject.

Reformers in nearly all transition economies did not foresee the rapid emergence of small enterprises from the ashes of the old Communist system. While this lack of recognition of the role of entrepreneurs is not surprising for those entrenched in the command economies of Europe, it stands as a substantial failure on the part of Western economic advisers as few of them predicted the important role entrepreneurs would play in the transition.

It would seem that advisors and transition policymakers perhaps should have paid more attention to the Austrian economists such as Mises, Hayek, Rothbard, Kirzner, and others. These scholars correctly argued that the entrepreneur is critical to economic growth—a theory that has been borne out by the experience of the transition economies.

Decades ago, Mises wrote:

The driving force of the market process is provided neither by the consumers nor by the owners of the means of production—land, capital goods, and labor—but by the promoting and speculating entrepreneurs. . . . Profit-seeking speculation is the driving force of the market as it is the driving force of production3.

Kirzner continued this line of thought. In the Kirznerian view of entrepreneurship,

A market consisting exclusively of economizing, maximizing individuals does not generate the market process we seek to understand. For the market process to emerge, we require in addition an element which is itself not comprehensible within the narrow conceptual limits of economizing behavior. This element in the market . . . is best identified as entrepreneurship.4

Unfortunately, actual policies in actual economies affecting actual human beings have been crafted by economists who have, for the most part, largely ignored entrepreneurial activity. That activity is even more important in emerging markets and transition economies and building a theory that accommodates that role is an important missing piece in the structure of modern economic theory. Perhaps the Austrian emphasis on the role of the entrepreneur will be pulled into the mainstream theory now that the transition policy failures are shedding light on this important issue.

  • 1. See pp. 64–65 Henderson & Quandt.
  • 2. See Christopher Woodruff and John McMillan "The Central Role of Entrepreneurs in Transition Economies" Journal of Economic Perspectives Vol. 16, No. 3 Summer 2002: 153–70.
  • 3. See Ludwig von Mises. 1949. Human Action: A Treatise on Economics. Pp. 325–326.
  • 4. See Israel Kirzner. 1978. Competition and Entrepreneurship. Pp. 31–32.
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